Don’t bother with Marshall’s new book

Warren Buffett would not get a job with a hedge fund today, according to Sir Paul Marshall, co-founder of Marshall Wace, one of the most successful alternative investment powerhouses.

Sir Paul, 60, is musing on what makes a good fund manager, and the Sage of Omaha, who is lauded by many as the greatest stockpicker of all time, does not quite make the grade.

His Sharpe ratio is only about 0.7. “Well, 0.7 wouldn’t get you into Marshall Wace or any of the top hedge funds.”

The Sharpe ratio is a measure of a fund manager’s returns adjusted for the amount of risk they are taking. Most of Sir Paul’s team at Marshall Wace are on 1.5 or better.

He admires Mr Buffett, he says, but not that much, and says that his success is largely down to two factors: always backing Wall Street and using the float in his insurance company investments to leverage his investments.

Tsk, this was explained 7 years ago at Forbes.

That’s one form of leverage that Buffett has used. The other is that he went and bought an insurance company or three in the first place. He made good money as an investor first, yes, he very much did. Which he then used to purchase his way into the insurance business. He then applied his investment technique, as the Economist describes it, to the much larger investment funds that the insurance company controlled. Those funds being a good multiple of the funds that it had cost to purchase the company.

Imagine, just as a made up numerical example, that Buffett outperformed the market every single year by 1%. Another made up number, he started with $1 million. He’s going to, over the decades, make himself a very rich man that way. But look at it this way: if he uses the $1 million to purchase control of an insurance company with $10 million to invest, then he gets that 1% outperformance on that $10 million, then he’s going to be making himself richer ten times faster than by not leveraging up by buying the insurance company. For of course the outperformance in the investments flows to those who own the insurance company.

15 thoughts on “Don’t bother with Marshall’s new book”

  1. The period of time over which you evaluate fund manager performance is what counts. If they can really maintain a Sharp of 1.5 over 5 years or more, then it might be worth taking their views seriously. Reversion to the mean and blind chance are quite powerful

  2. Even though the insurance float provides “leverage” it no longer facilitates a high Sharpe ratio since regulators require the overwhelming bulk of those insurance companies’ assets that match insurance liabilities to be invested in low-risk assets which currently have negligible or negative real returns. Saying that Warren Buffet’s current rate of return on his overall portfolio of investments is low is trivially correct but highly misleading as several insurance companies have reported investment returns lower than inflation in recent years.
    It is worth noting that the latest Credit Suisse Hedge Fund Index shows that Hedge funds overall (and every sub-category except “Emerging Markets which has a Sharpe Ratio of +0.07) have *negative* Sharpe Ratios. Warren Buffet’s +0.7 wouldn’t make it into a Hedge Fund today because it’s *too good*

  3. OK, I’ve looked at the best performing investment trusts over the last 3 years, only one of them has a Sharpe of 1.5 or greater, and that was just for last year. I call bullshit on Mr Marshall

  4. As John77 says, hedge funds generally seem to involve high fees and execrable performance. Putting your money in a wheelbarrow would outperform most hedge funds most years as far as I can tell

  5. Bilbaoboy, pretend to be a hedgie, charge 2% for the use of the barrow and buy champagne or sparkling wine of your choice

  6. The Sage of Omaha to be imagined talking to Marshall in a Harry Enfield Brummie accent

    “I am considerably richer than Yow!”

  7. Dennis, Climate-Change Denying Fruitcake

    World’s fourth richest man not all that, says UK’s 221st richest man.

    Marshall shows an amount of envy worthy of the Sage of Ely.

  8. Warren Buffet (as all good insurance fund managers used to do) can make his investments with the intention of holding onto them for years or decades. Hedge funds generally operate within a horizon of a few months.

    Who knows what Berkshire Hathaway’s return on BNSF will eventually be? But history* tells us that it’s likely to be better than average.

    * past performance is no guide, yadda, yadda

  9. Diogenes and john77 hit the proverbial nail on the head. I too call bullshit on Marshall. Although to be fair he is 1000 times better than I am at making himself rich, so I don’t call too loudly.

    They really annoyed me actually. Their big strategy was to essentially outsource money management decisions to brokers, who could enter trading ‘signals’ into their electronic system. A neat but fairly simple algorithm would track which of them was most successful and allocate real money to their signals, although they never knew exactly what MW would act on.

    The brokers loved it – they got to play at being real fund managers, and they would get hefty bonus checks if they were successful at providing signals; much better than plain old trading commission (under the old system, we’re going back a few years now)

    As a system it’s actually a fine way of managing speculative money. But the big problem was that, in my humble opinion, allegedly etc, a lot of the excess returns generated were due to low level corruption.

    – Brokers market stocks heavily and can move prices at times doing so. If you were about to do a big push on a stock, with research published at 8am and calls all day, and analyst meetings all the week after that… you enter your trading signal at 8.00.01 and essentially MW get to front-run your entire client base while you ‘reverse broke’ your idea to the whole market. It’s not illegal as such, but it’s not very ethical.

    – Brokers often accompany companies on roadshows to meet investors. Across days of meeting, car rides and dinners, something important might slip out out that is basically inside information. If you don’t document it, talk to your clients or publish on it, but just slip a quick trading signal to MW, you can do well. MW have technically clean hands, outsourcing insider trading risk.

    – Brokers work in the same firms as investment bankers by and large. But the Chinese walls can be very leaky – analysts, for example, can be restricted on a stock due to a significant corporate action, but not restricted on other stocks where there are big indirect impacts. They can’t publish research on these kind of hints, but they can tip off their broker colleague and get an entry in the MW system.

    And so on… now this would all be fair game if everyone was playing by the same rules, but we’re not (in various boring ways I won’t go into). This kind of activity is what I think a lot of the MW edge was built from.

  10. Very interesting Oblong. Someone should do some research on those strange changes in price between market close and opening. Plus the intraday moves where no volume is shifting

  11. @ Diogenes
    The police do occasionally commission such research, the London Stock exchange a bit more frequently. Very rarely can they prove anything but when they can the police do prosecute.
    Some, probably most, of the changes are legitimate ones due to the jobbers responding to news items occurring during the time the market is closed and/or movements in the American and Japanese markets that affect the price of stocks quoted both in London and Tokyo and/or America with knock-on effects on comparable stocks in London. This naturally makes it more difficult to instantly spot many of the price moves due to insider trading.

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